LOS ANGELES — In a research paper released today, "Greece's Unpleasant Arithmetic: Containing the Threat to the Global Economy," Milken Institute economists Jim Barth, Cindy Li, and Penny Prabhavivadhana explore how a country that accounts for less than one fifth of one percent of the world population, and less than half of one percent of global GDP, has the potential to trigger a global recession. Despite its tiny size, Greece is edging ever closer to severely disrupting global financial and economic markets, unless decisive corrective action is taken.
Among the paper's findings:
- Greek debt is comparatively small, but because so much is held by a few major banks in Europe, a default would disproportionately hit these institutions, and could disrupt global economic growth, Greece has the largest debt-to-GDP ratio among the so-called periphery countries of the European Union, at 143 percent. Greece's projected deficit for the year is 8.5 percent of GDP, well above its previous target and reaching levels at which it may be impossible to avoid default on its debt.
- The high and rising debt-to-GDP ratio puts a heavy economic and political burden on the Greek government. The fiscal austerity measures demanded by such a level of debt service may be so severe that they impede economic growth — so that whatever loans Greece receives may simply postpone rather than avoid a default.
- Based on two separate measures of investor expectations of Greek default, the probability of default by Greece on its sovereign debt is between 89 and 97 percent.
- Total exposure of non-Greek European banks to Greek debt is $43 billion, and almost two-thirds of that exposure is at French and German banks.
- Six banks have high levels of exposure to the sovereign debt of the GIIPS European periphery economies (Greece, Ireland, Italy, Portugal and Spain): Dexia, Commerzbank, BNP Paribas, Societe Generale, Credit Agricole, and Deutsche Bank. Dexia was recently bailed out by the Belgian and French governments.
With limited means and appetite by other European nations to bail out Greece (and possibly the other GIIPS countries as well), an alternative for Greece is to default on its debt through a substantial write-down of its face value, the Milken Institute researchers explain. This would lighten the political, economic and financial burden on the Greek government. Such a step, however, would adversely affect the financial condition of the banks holding that debt, which could require them to raise additional capital. If banks are unable to do so on their own, governments may find it necessary to recapitalize the banks. But this, in turn, could result in the downgrade of sovereign debt of countries such as France, pushing up its borrowing cost at a difficult time.
Commenting on the policy implications of the report, Ross DeVol, chief research officer of the Milken Institute, says, "European policy makers must end the practice of doing too little, too late — enough so that financial markets don't crater on Mondays after each weekend's emergency meetings. Given the potential contagion risk for the world economy, it would be preferable to err on the side of doing more than what seems necessary."
DeVol concludes: "Greece should not be allowed to be the trigger for a global recession — and it can be avoided with the proper policy actions."
Download the full report here.